Growing Economy Continues to Struggle

Inflation remains in check, but gaining economic momentum will be a challenge in the coming months.

By Jerome Idaszak, Associate Editor, The Kiplinger Letter

July 31, 2008

The economy, helped by rebate checks in the second quarter, remains weak, with scant growth ahead during the second half. The recent decline in gasoline prices will help consumers a bit. But it won't offset the drag from job losses, wages that aren't keeping pace with inflation and still-high energy prices.

Gross domestic product grew 1.9% in the second quarter, the Commerce Department said Thursday, an improvement over the annualized 0.9% gain in the first three months of 2008.

The ongoing weakness in the economy should keep officials at the Federal Open Market Committee on hold at their next policy meeting on Aug. 5. Although more FOMC members are publicly voicing concerns over inflation, fueled mostly by higher energy prices, a rate hike now isn't what a feeble economy needs.

We look for GDP growth to gain about 1.5% this year, led mainly by strong exports and a lessening drag from housing. In 2009, as the problems in the housing market subside even more, GDP likely will increase between 1% and 2%.

The economy entered this year in slightly weaker condition than previously reported. The Commerce Department says that new information resulted in lowering the fourth quarter 2007 GDP to minus 0.2% from plus 0.6%. The last quarterly contraction was minus 1.4% in the third quarter of the 2001 recession.

For the year 2007, GDP was revised to a 2% increase from 2.2%. A bigger downgrade was averted, thanks to a positive revision in the second quarter to 4.8% from 3.8%. Referring to the changes, J. Steven Landefeld, director of the Commerce Department’s Bureau of Economic Analysis, says that over the past three years, housing has turned out to be weaker than thought, while exports and business spending on equipment and software have been stronger.

The revisions occur periodically because complete data gathering takes a while in an economy as large and diverse as in the U.S. For example, the Commerce Department recently got fresh numbers for state and local government spending in 2005.

Plenty of businesses, big and small, are reporting weakness in the present, even though some recent economic information, such as a report on durable goods orders in June, was solid. The Federal Reserve staff, in a survey of economic conditions, found that "activity slowed somewhat" between its early July survey at the third quarter’s start and its June survey at the second quarter’s end.

Looking at details in the GDP report, export growth continued strong, up 9.2% in the second quarter after a 5.1% gain in the first quarter. Consumers boosted spending, to 1.5% from 0.9%, and business spending increased 2.3% on the heels of a 2.4% first quarter rise. Federal government spending was up 6.7% following an increase of 5.8% in the first quarter of the year.

Within the broad categories, too, weakness is apparent. All gains in business spending came in offices and other structures, which show signs of slowing. Business spending on new equipment shrank last quarter by 3.4%. And gains in consumer spending, which accounts for two-thirds of GDP, were tepid.

There are bright spots. Inflation remains contained. The personal consumption deflator, minus food and energy, rose 2.1% in the quarter, down from 2.3% the previous quarter and closer to the Fed's goal that inflation not exceed a 2% rate over time. Also, housing construction continued to shrink, but its 15.6% drop was less severe than the first quarter decline of 25.1%.

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